Are you feeling burdened with student loans? Consolidating your loans might help you turn over a new leaf.
Student loan consolidation can simplify your monthly payments and potentially reduce your interest rate, resulting in a lot of savings in the long term. At the same time, loan consolidation isn't for everyone, so you need to make sure you understand all the terms before taking on a new contract.
This guide will go over the ins and outs of student loan consolidation so you know what it means, how to do it, and whether or not consolidating your student loans will give you a fresh financial start. First, what exactly is student loan consolidation?
What Is Student Loan Consolidation?
Student loan consolidation, a way to refinance student loans, bundles all of your student loans together and combines them into one new loan with a single monthly payment and a new interest rate. Ideally, that interest rate is lower than the ones you're currently paying.
Loan consolidation programs might also offer you more flexible terms to pay off your loans, whether that means buying more time or getting your loans paid off as fast as possible. Either the government or a private lender, like a loan consolidation company or bank, takes some or all of your various loans and distributes a new single loan.
Depending on which entity you use to consolidate your loan, you can consolidate federal loans, private loans, or both. Read on to learn about which loans you can consolidate.
If you go through the US Department of Education, then you can only consolidate your federal loans.
What Kind of Student Loans Can You Consolidate?
Some people have federal loans, like a Stafford, Perkins, or Plus loan, some people have private loans from lenders like Sallie Mae or a bank, and some people have a mix of both. You might be able to consolidate all of your loans, depending on the approach you take.
The federal government only allows you to consolidate federal student loans, like direct subsidized or unsubsidized Stafford loans, Perkins loans, and Direct Plus loans. Private lenders either allow you to consolidate just private loans or both private and federal loans together.
You might be wondering whether you should try student loan consolidation through the government or a private lender, and the answer is that there are pros and cons to both programs. Let's take a look at the advantages and disadvantages of both options.
Which loan consolidation plan will win the fight against high interest rates?
Federal Vs. Private Student Loan Consolidation
When you take steps to consolidate your student loans, you have two potential avenues - the federal government or a private lender. There are different rules, benefits, and drawbacks for both options, and guidelines further vary among private lenders. Let's look at how each option works, its pros and cons, and how to apply for student loan consolidation.
Student Loan Consolidation From the Federal Government
The US Department of Education offers a Direction Consolidation loan that replaces all of your federal student loans into one loan with a single payment and new terms. To apply for Direction Consolidation loans, your current loans must be in a grace period or repayment.
Federal loan consolidation doesn't usually lower your interest rates much overall. However, it can be useful because it offers more flexible repayment terms and forgiveness options. The reason it doesn't change your interest rates much is that this program uses a new rate that's a weighted average of your old one.
To determine the interest rate of Direct Consolidation loans, the Department of Education takes a weighted average of your current interest rates and then rounds to the nearest 1/8th of a percent. To calculate this weighted interest on your own, you would multiply each loan by its interest rate, add the products together, and then divide by the sum of your loans. Finally, you would round to the nearest 1/8th percent.
There are several calculator tools to help you estimate your weighted average online, or you can crunch the numbers yourself. Consider the following example to learn how to calculate the weighted average of your federal interest rates.
Calculator at the ready? It's time to crunch some numbers.
Calculating the Weighted Average of Your Interest Rates: An Example
A Direct Consolidation Loan from the federal government recombines your loans and gives you a new loan with a new interest rate. The student loan consolidation rates are a weighted average of your current interest rates. You can estimate this weighted average in five steps.
Let's say you have one federal loan for $10,000 with a 6.5% interest rate and another for $2,000 with a 5% interest rate.
- Loan 1: $10,000 with 6.5% interest
- Loan 2: $2,000 with 5.3% interest
These are the five steps you would take to figure out your weighted average:
Step 1: Multiply each loan amount by its interest rate. These products represent the "per loan weight factor."
- Loan 1: $10,000 x 0.065 = 650
- Loan 2: $2,000 x 0.053 = 106
Step 2: Add the products together. In this example, we have two loans, so we'll add two products together.
- 650 + 106 = 756
Step 3: Add the loan amounts together.
- $10,000 + $2,000 = $12,000
Step 4: Divide the sum from step 2 (the "total per loan weight factor") with the sum from step 3 (the total loan amount). Multiply by 100 to turn the decimal into a percentage.
- 756 / 12,000 = 0.063
- 0.063 x 100 = 6.3%
Step 5: Round up to the nearest 1/8th of a percent. The percentage should end in 0.125, 0.250, 0.375, 0.500, 0.625, 0.750, 0.875, or 1.000. If your weighted average already looks like one of these decimals, then you don't need to round up.
- 6.3 + 0.075 = 6.375%
With our two loans, the new weighted interest rate would be 6.375%. You can see how this is different than a non-weighted average, which would simply be 5.9% ((.065 + .053) / 2 x 100 = 5.9%).
Now that you have a sense of how the government's Direct Consolidation loan works, let's look at the pros and cons of consolidating your loans through the federal program.
Direct Consolidation Loans use a weighted average, so bigger loans factor more heavily into the new interest rate than smaller ones.
Pros of Student Loan Consolidation Through the Government
Here are some potential benefits of consolidating your federal student loans through the US Department of Education.
- Simplify monthly payments by reducing payments to just one.
- Get a fixed interest rate. (Recent federal loans already have fixed interest rates, but loans distributed before July, 2006 have variable interest rates.)
- Access all the usual repayment plans or switch to a 30-year repayment plan.
- Become eligible for Public Service Loan Forgiveness (PLSF), which forgives your loans if you've worked full time in a public service or nonprofit job and made 120 on-time payments.
- Can still access Student Loan Forgiveness programs.
- Can still set up an income-based repayment plan.
- No origination fees or pre-payment penalties.
Cons of Student Loan Consolidation Through the Government
These are some of the major drawbacks of getting a Direct Consolidation loan through the federal government.
- Can't consolidate private student loans.
- May slightly raise interest rates overall.
- Lose the Perkins Loan Forgiveness program, which cancels Perkins loans for people in public service jobs, like teachers, firefighters, and public defenders, after five years. (You'll gain access to PLSF, as mentioned above, but the 120-month count starts with the Direct Consolidation Loan.)
Given the pros and cons of federal loan consolidation, who should consider applying?
If your loans are mostly private, then the federal loan consolidation program isn't the right road for you.
Who Should Apply for Student Loan Consolidation From the Federal Government?
The Direct Consolidation loan makes sense if you have several federal student loans and are looking for more flexible repayment plans. Typically, only people with $30,000 or more in student loan debt have access to a long-term payment plan. If you consolidate your loans, you can get a 30-year repayment plan regardless of the amount you owe. Just keep in mind that a longer term on consolidation loans may mean that you pay more in interest in the long run.
You may also benefit from the Public Service Loan Forgiveness program, which is only available to those with a Direct Consolidation Loan. If you're already eligible for the Perkins forgiveness program, then you probably shouldn't consolidate, as you'd lose that option. If you do decide to apply for federal direct loan consolidation, how do you apply?
How to Apply for a Direct Consolidation Loan From the Government
You can apply for a consolidation loan through the federal student aid website. Alternatively, you can print out the Direct Consolidation Loan Application and Promissory Note and mail it in.
Whether you fill out the form online or print it out, you'll write in your personal information and details about your loans. You'll also select a payment plan for the consolidated loan, read and agree to the terms and conditions, and sign the form. If you want to apply for an income-based repayment plan, then you'll need to provide your income details.
The Department of Education usually takes about 30 business days to process your application. Once it's approved, your new loan will immediately go into effect, and you'll replace your multiple payments with one single, consolidated payment toward the new loan. While your application is being processed, you'll need to continue paying off your various loans.
While the federal consolidation program can be a useful one, it completely leaves out private loans. If you're looking to refinance private student loans, consider the second approach of going through a private lending company or bank.
Once you apply, you'll have to wait one full moon cycle for your new consolidated loan.
Student Loan Consolidation From a Private Lender
Your second avenue for student loan consolidation is going through a private company or bank. Unlike the federal program, private lenders look at factors like your salary, credit score, amount of debt, and whether or not you have a co-signer to determine whether or not they approve you to refinance student loans.
Like the federal program, private lenders will take all your loans and distribute a new loan with a single monthly payment and interest rate. Unlike the federal option, the new interest rate is not an average of your pre-existing interest rates, but rather an entirely new rate based on the financial factors mentioned above. That means you could potentially lower your interest rate overall!
The interest rates on consolidated loans are commonly set at 4.5% or higher. You can typically choose a fixed rate or variable rate. Variable rates will start lower than fixed rates, but they have the potential to increase over time.
If you don't have a strong credit score or co-signer, then you might not get an attractive interest rate or even be approved for loan consolidation at all. Even if you do get approved, you need to make sure that the company won't charge you an origination fee (usually a certain percentage of your principal) or penalties for paying off your loan faster than the amount of time stipulated in the payment plan.
Some private lenders will only consolidate private loans, while others, like the companies and banks suggested below, will refinance both private and federal student loans. If you have a mix, then choosing a student loan company that will refinance student loans of both types will probably be your best option.
Let's look at the pros and cons of student loan consolidation with a private lender, followed by some of the best loan consolidation companies and how to make an inquiry.
Pros of Student Loan Consolidation Through a Private Lender
These are some potential benefits that can come with consolidating your loans through a private lender. If few of these benefits apply or are available to you, then you probably shouldn't consolidate your loans.
- Simplify payments by combining all loans into a single monthly payment.
- May be able to get a lower interest rate on most or all of your loans, thereby saving money in the long run.
- Access to a 20-year repayment plan that may not have been available to you previously.
- Access to a 5-year repayment plan, so you can pay off your debt in a short time period.
The problem with variable interest rates is that they could just keep going up.
Cons of Student Loan Consolidation With a Private Lender
These are some of the drawbacks that may come with private student loan consolidation. Before agreeing to any kind of contract, make sure to read the fine print for any hidden fees, like origination fees or pre-payment penalties.
- Variable interest rates could increase over time, leaving you with a higher interest rate than you had before you consolidated your loans.
- Your application could be rejected if you have poor or even fair credit.
- Might not qualify for a better interest rate.
- May have extra fees, like application fee, origination fee, or pre-payment penalties.
- May hurt credit score if private lender runs a hard credit check to evaluate your application.
- May lose federal benefits and protections, like loan forgiveness programs and income-based repayment plans.
Given these potential advantages and disadvantages, who should explore this loan refinancing option?
Who Should Apply for Student Loan Consolidation From a Private Lender?
If you have private student loans or a mix of private and federal, then you might apply for loan consolidation through a private lender to see what kind of offer the company gives you.
You should probably only apply if the application is free and the company won't run a hard credit check, thereby hurting your credit score, with its initial evaluation of your application (if you decide to move forward, the company will eventually run a hard credit check).
If you have an especially strong credit score and/or a co-signer with a strong credit score, then you might qualify for a lower interest rate and lower monthly payments than you currently have. With lower monthly payments, you might even be able to handle a shorter repayment plan and get rid of your loans fast.
It's important to have strong credit or a co-signer to get a lower interest rate. You probably won't qualify for a lower interest rate on student loans with bad credit.
If you're considering applying for a consolidated loan, then you should also make sure you aren't eligible for federal perks, like forgiveness programs or income-based repayment plans, as you'll probably lose these.
Furthermore, you should make sure that you won't have to shoulder the costs of penalties, like an origination fee. Some banks charge you a substantial percentage of your principal to disburse the consolidated loan, making the entire process not worth it in the short or long term.
If you are interested in seeing whether you qualify for student loan consolidation, check out some of the best private lenders below.
These are some of the most trustworthy private lenders when it comes to consolidation loans.
Best Student Loan Consolidation Companies for 2016
I chose these lenders as the best ones because they offer consolidation options for both undergraduate and graduate loans and will consolidate both private and federal loans. They also offer some of the most competitive student loan consolidation rates. Finally, these companies offer a variety of repayment plans that range between five and 20 years.
- Citizens Bank: offers competitive interest rates for people with strong credit. Fixed rates range from 4.74% to 9.39% and variable rates range from 2.18% to 7.93%. It also offers an additional discount on the interest rate if you open a Citizens Bank checking account. Your undergraduate loans must total between $10k and $150k, while graduate loans can total up to $170k.
- College Ave: this student loan company offers fixed rates between 4.74% and 8.5% and variable rates between 2.5% and 7.25%. Your loans must amount to somewhere between $5k and $250k
- Common Bond: offers fixed rates between 3.5% and 7.49% and variable rates between 2.13% and 5.68%. Your loans must add up to $10k or higher.
A few other highly rated student loan consolidation companies are LendKey, RISLA, Earnest, and Sofi. You can also compare options and offers with the search engine and comparison tool at Credible.com.
If you do think private student loan consolidation could be a good option for you, read on to learn how to consolidate student loans.
How to Apply for Student Loan Consolidation From a Private Lender
You can submit a preliminary application for student loan consolidation online. The private companies and banks all have their own online application, or you can fill one out and look at offers through Credible. The applications all ask for your personal information and details about your loans. Some might ask for your social security to do a soft credit check, which shouldn't impact your credit score.
You'll find out whether or not you've been pre-approved immediately after submitting your application. If you want to move forward, then you'll provide additional information.
To give you an example of the process, I've included screenshots from the loan consolidation application from the student loan company, College Ave. Here's the first part of the College Ave application.
After filling out your personal information and salary, you'll move onto the second page to review the general terms of a College Ave contract.
After you review these details, you'll indicate whether or not you're applying with a co-signer. Having a co-signer with strong credit can potentially get you a lower interest rate. If you have strong credit yourself, then you probably don't need one.
The last page of the process tells you whether or not you've been approved for a consolidation loan. If you have, you'll move onto next steps, which including choosing a specific loan and repayment plan.
If you're interested in private loan consolidation, you should take some time to explore your options. Apply to several private lenders at once and compare their offers. If you decide to move forward, then you'll know that you're getting the best one.
By the way, some banks, like Citizens Bank, will give you a 0.24% discount on your interest rate if you set up automatic payments, plus an additional 0.24% if you open a bank account with them. Based on your loan amount and repayment plans, these discounts could save you a good deal of money in the long run.
After you apply, you'll wait somewhere between a few weeks to a month or two for your consolidated loan. As with any consolidation application, you should continue paying off all of your loans in the meantime.
In closing, let's review the key points you need to know if you're interested in consolidating your student loans through the federal government or a private lender.
Get your interest rate as low as possible so you can spend your money on more important things, like rent, saving for retirement, or a gemstone tiara for your ceramic piggy bank.
How to Consolidate Your Student Loans: Key Points
Consolidating your federal and/or private student loans might save you a lot of money. It can streamline your plan into a single monthly payment and save you thousands of dollars on interest over the life of your loan.
The federal consolidation program can open up for more flexible repayment plans, plus it makes you eligible for an additional forgiveness program. Private lenders will consolidate both federal and private loans, and they may offer you better interest rates and lower monthly payments that save you money in the long run.
Make sure you consider all of pros and cons of loan consolidation carefully, and read any and all fine print before signing onto a new loan agreement. If you've done your research and feel confident that you understand the new contract, then you may very well be able to simplify your loan payments, reduce the burden of student loans, and ultimately, save money on your student loans.
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Rebecca graduated with her Master's in Adolescent Counseling from the Harvard Graduate School of Education. She has years of teaching and college counseling experience and is passionate about helping students achieve their goals and improve their well-being. She graduated magna cum laude from Tufts University and scored in the 99th percentile on the SAT.